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FTSE 100: The Rewards Outweigh The Risks

One of the difficulties of investing in shares is that there is never a perfect time to buy. In other words, there are always potential threats and dangers lurking just around the corner that could cause the FTSE 100 to fall heavily. The difficulty, therefore, is in determining whether the potential rewards on offer sufficiently compensate an investor for the risks they are set to take.

Nothing new

Clearly, there are a number of risks facing the FTSE 100 at the moment — just as there have been since the index was born in 1984. For example, the price of commodities could fall and hurt the 17% of stocks on the FTSE 100 that are resource-focused. Furthermore, the potential for a Brexit could weigh on the index in the near term and the continued slow growth of the Eurozone may cause investor sentiment to remain weak. In addition, US interest rate rises may dampen economic growth, while China’s transition towards a consumer-focused economy is proving to be rather rough, as opposed to smooth.

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However, such problems are nothing new and the FTSE 100 has faced worse in the past and still climbed from 1000 points in 1984 to over 6000 points today. For example, Black Wednesday, the dot.com bubble, 9/11 and the credit crunch have all had a negative impact on the FTSE 100 in the short run. But in the long run, the index has proved to be resilient and has delivered an annualised total return of over 9% in its 32 year history.

A long term view

As a result, the existence of risks today does not mean that the FTSE 100 will suddenly fail to make long term gains. Certainly, its price level could fall in the short run, but then again it could rise as well. In fact, forecasting in days, weeks and months tends to prove inaccurate even for the most seasoned of investors, so it may prove to be wise to instead take a long term view and focus on the overall risk/reward ratio, rather than just on the risks.

In terms of potential rewards, the FTSE 100’s valuation indicates that a higher price level than the current 6200 points could be on the cards. That’s because it has a price to earnings (P/E) ratio of only 13 and a yield of just under 4%. Furthermore, with the US economy continuing to perform well and now expected to be subject to only a small number of interest rate rises over the medium term, the outlook for global GDP growth (and therefore company earnings) remains upbeat.

Still very desirable 

Allied to this is a Chinese economy which could deliver stunning growth in the long run as it enters a new era where spending on infrastructure projects will moderate and consumer spending should pick up the slack. And while the Eurozone is seemingly a perennial disappointment when it comes to GDP growth, an ultra-loose monetary policy could begin to have a positive impact on its performance over the coming years.

So, while there are risks ahead for the FTSE 100, the rewards on offer seem to more than make up for them. As such, for long term investors, the FTSE 100 is still a very desirable place to invest.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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